Speed Reading: Top 10 Considerations When Doing M&A Due Diligence

Excerpt:

Planning a significant due diligence process can be
daunting, even for experienced deal makers. Some foresight and a little
preparation can make the process go smoothly. Spending a few hours at the
outset thinking through the process carefully can also save a client a
tremendous amount of time and money as the deal progresses. By anticipating and
preventing roadblocks, focusing in on key issues, determining what deliverables
will be most useful and avoiding duplication of efforts, an advisor can develop
an effective approach to any M&A due diligence process. Ensuring that
diligence findings are communicated efficiently and properly assimilated into
the deal negotiations makes all the effort worthwhile. This article outlines
ten practical tips for organizing a due diligence exercise to maximize the
benefits of the process, while staying on schedule and reducing costs.

Before starting due diligence, advisors and their clients should pause to
discuss the scope of the project. The discussion should cover the following
topics, among others:

Scope.
What is the scope of due diligence? Is the purpose of the diligence exercise
merely to identify issues that could impact the transaction valuation,
structure and/or deal timing, or are the diligence findings also expected to
form a basis for future integration work?

Work
Product. What kind of work product does the client want to receive?
Detailed document-by-document summaries or an executive summary that only
highlights material issues? The answer will be closely related to the scope of
the project and the expected audience for the report. Delivering a two-hundred
page report to a board of directors usually is not appropriate, but the head of
an integration team may be thrilled to receive that level of detail.

Materiality.
Is there a materiality threshold below which the findings are unlikely to
justify the expense of performing diligence? This question is becoming
increasingly important because virtual data rooms have made it possible for a
seller to give a buyer access to its entire electronic contract database
without making any effort to distinguish between a multi-year, multi-million
dollar key supplier agreement, on the one hand, and a landscaping contract for
the corporate headquarters, on the other hand.

Transaction
Structure. How will the transaction be structured? If the target is a
public company that files periodic reports and audited financial statements
with the SEC, a buyer might elect to (or, in a hostile deal, might have to)
rely on a more cursory due diligence review (understanding, of course, that
relying primarily on the seller's public disclosures will leave the buyer
exposed to undisclosed risks). In contrast, if the transaction is a small asset
sale with detailed disclosure schedules, the due diligence may need to be much
more granular.

Risk
Allocation. What liabilities is the buyer expected to assume? If the
business deal is that the buyer will be fully indemnified against all
environmental liabilities, for example, it may be more important for the
buyer's diligence team to spend its time and money analyzing the credit risk
associated with accepting an indemnity from the seller rather than performing a
detailed review of the underlying environmental risks.

Known
Risks. Should the team focus on any particular types of risks given the
identity of the seller or the nature of the industry?

2. Pulling Together the Team and Coordinating Results

When it comes to performing due diligence, advisors are not "one size
fits all". Depending on the type of transaction and the industry, a buyer
may need to hire multiple specialized diligence providers, such as a tax and
financial accounting firm, an actuarial firm (more common in certain insurance
deals), a loan portfolio consultant (more common in loan portfolio or banking
deals), outside counsel including, in some cases, local counsel, an employee
benefits/human resources consultant, an environmental consultant and/or a real
property title search firm.